Time Warner to Sell 5% AOL Stake to Google for $1 Billion

Rebuffing aggressive overtures from Microsoft, Time Warner has agreed to sell a 5 percent stake in America Online to Google for $1 billion in cash as part of an expanded partnership between AOL, once the dominant company on the Internet, and Google, the current online king.

At stake in this battle was leadership in Internet advertising, which is a growing threat to other media companies. The loss is a blow to Microsoft, which had sought AOL as a partner in its advertising venture to undercut Google, its potent rival.

Though Google is only seven years old, its lucrative search advertising business and its technical prowess could enable it to offer consumers free software and services that would directly attack Microsoft's core software business.

While the terms of the proposed five-year deal are largely set, it will not be final until it is ratified Tuesday by the Time Warner board, an executive briefed on the talks said.

Google has agreed to give AOL ads special placement on its site, something it has not done before. Until now, Google prided itself on its auction system for ads, which treated small businesses on an equal footing with its largest customers.

By agreeing to change its business practices for this deal, Google fends off what could have been a significant challenge from a combination of AOL and Microsoft and cements its position as far and away the largest seller of search advertising.

"This is Google's first test as a chess player in a major corporate battle," said John Battelle, the author of "The Search: How Google and its Rivals Rewrote the Rules of Business and Transformed Our Culture."

"They are saying, 'We will take some of our pawns and block the move to our queen by Microsoft,' " he said. "Until now, Google has said, 'We don't think about our competitors. We spend all our time building better products for our users.' "

Negotiations among the companies reached a fevered pitch Thursday night, executives briefed on the talks said, when teams from Google and Microsoft were in separate conference rooms in the Time Warner Center in New York and executives from the media company walked back and forth between them.

At the same time, Time Warner was holding its corporate Christmas party at the Mandarin Oriental Hotel, which is also in the Time Warner Center, overlooking Central Park.

At 9 that evening, Richard D. Parsons, the chief executive of Time Warner, left the party to tell Eric E. Schmidt, Google's chief executive, who was leading its negotiations in another part of the complex, that he would accept Google's recently sweetened offer.

According to one executive, Mr. Parsons called Steven A. Ballmer, Microsoft's chief executive, at 10:30 a.m. Friday to tell him that the deal that Microsoft had so eagerly sought -- and had thought it had won -- was going to Google.

Microsoft had proposed that it and AOL form a joint venture to sell advertising on their own sites and eventually on other sites. Now Microsoft will compete in the search business as a distant No. 3, behind Yahoo.

Representatives of Time Warner, Google and Microsoft declined to comment about the negotiations.

The deal is a coup for Mr. Parsons because less than a year ago, Wall Street and even people within the company were treating AOL as a declining asset and a drag on Time Warner. The deal is meant to confirm Time Warner's claim that AOL is worth $20 billion, a number many had said was too high.

Yet investors did not seem to see Google's investment as a sign that Time Warner's stock was undervalued, as Mr. Parsons hoped they would. Time Warner closed yesterday at $18, up 34 cents. Google closed at $430.15, up $20.95. Microsoft finished at $26.90, down 81 cents.

In the last year, Time Warner has pursued a new strategy to replace its declining profits from its Internet access service with advertising revenue from AOL.com and other free Web sites. It has enjoyed enough of a resurgence to attract the courtship of not only Google and Microsoft, but for a time Yahoo, the News Corporation and Comcast.

Time Warner ultimately chose to go with Google because its proposal was simpler than the Microsoft one. Moreover, the lucrative offer promised to help drive more traffic to AOL's Web sites.

Google has been providing Web search and search ads for AOL since 2002. In the new arrangement, Google will offer promotion to AOL in ways it has never done for another company, two executives close to the negotiations said.

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If a user searches on Google for a topic for which AOL has content -- like information about Madonna -- there will be a special section on the bottom right corner of the search results page with links to AOL.com. Technically, AOL will pay for those links, which will be identified as advertising, but Google will give AOL credits to pay for them as part of the deal. They will also carry AOL's logo, the first time Google has agreed to place graphic ads on its search result pages.

Google will also provide technical assistance so AOL can create Web pages that will appear more prominently in the search results list. But this assistance will not change computer formulas that determine the order in which pages are listed in Google's search results.

Google will also make a special effort to incorporate AOL video programming in its expanding video search section and it will feature links to AOL videos on the video search home page. These links will not be marked as advertising.

An executive involved in the talks said Time Warner asked Microsoft to give AOL similar preferred placement in advertising and in its Web index and that Microsoft refused, calling the request unethical.

Mr. Battelle said that while each of Google's accommodations to AOL could be seen as consistent with past practices, "each of them represents a step closer to a slippery slope."

He added, "What they are giving away is the perception in the market place that Google isn't for sale."

An executive involved in the talks said that as recently as two weeks ago, Mr. Parsons told Microsoft executives that he preferred their bid. Still, that executive said, Microsoft had the impression that executives in the AOL unit preferred to work with Google. Yesterday, several AOL executives said that was true.

A turning point, in Microsoft's view, was an article that Stephen M. Case, AOL's co-founder and the architect of the deal with Time Warner, wrote in Sunday's Washington Post calling for the company to be split up, two executives involved with the negotiations who were familiar with Microsoft's views said.

Mr. Case's argument was timed specifically to encourage a Google deal, said one person close to him. Mr. Case's longstanding animosity toward Microsoft played a part, this person said, but his main reasoning was that Google has proved itself far smarter about the Internet than Microsoft. That person said that Mr. Case thought that a deal with Google was the best of all the options other than spinning off AOL. Carl C. Icahn, the financier who, like Mr. Case, has been pressing Time Warner to split up the company, was not mollified by the Google deal.

"I don't want them doing anything that could preclude them from selling or spinning off AOL in the future," Mr. Icahn said. "But the real point is that Parsons shouldn't be running AOL, and I shouldn't be running AOL, either. As Parsons says, 'We're two guys who grew up in Queens 40 years ago.' Neither of us understands the digital world." Then he added, "But I could do infinitely better."

Edward I. Adler, a Time Warner spokesman, said: "We're not going to comment on every little thing Mr. Icahn says. The management team running Time Warner knows AOL's business in great depth and any potential transaction that we may or may not do will be done in the interest of all the shareholders."

While AOL's deal with Google is not as complicated as the proposed joint venture with Microsoft, Google is offering several ways to help AOL enhance its advertising sales business, executives briefed on the negotiations said.

Under the current arrangement, Google sells all the search ads that appear on AOL's sites. This year, Google's revenue from ads on AOL will be roughly $500 million, estimates Jordan Rohan, an analyst with RBC Capital Markets. Of that, Google will pay AOL about $430 million.

Under the new deal, AOL's sales force will also have the ability to sell search advertising that appears only on AOL's sites, even though those ads will compete for placement with those sold by Google. AOL's sales force will also have the right to sell some display advertising that will be placed on the vast network of Web sites for which Google sells ads.

AOL executives are attracted to the idea of offering marketers a full range of Internet advertisements, from splashy ads on the home page of AOL.com to text ads.

Mr. Larry Haverty, a fund manager with Gabelli Asset Management, a Time Warner shareholder, said the deal with Google was "very reinforcing to the idea that Parsons is doing what he can to highlight the values."

For Google, he added, "there are two good reasons to do this deal: one, it's chump change; and, two, it really makes life difficult for Microsoft."

Andrew Ross Sorkin contributed reporting for this article.

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A version of this article appears in print on December 17, 2005, on Page C00001 of the National edition with the headline: Time Warner to Sell 5% AOL Stake to Google for $1 Billion. Order Reprints|Today's Paper|Subscribe